November 7, 2018
Please read important disclosures HERE
November 7, 2018
Please read important disclosures HERE
In June of 1930, the U.S. Congress passed the Smoot-Hawley Tariff Act with the goal of protecting American jobs and farmers from foreign competition during the early stages of the Great Depression. Shortly after the tariffs were applied, other countries began to retaliate and in just four years world trade declined by 66%1. In 1934, shortly after Franklin D. Roosevelt became president, the Reciprocal Tariff Act was signed into law, which reduced tariffs and liberalized U.S. trade policy. Many believe this law marked the beginning of global free-trade policies that persisted into the 21st century.
Andy Wong / AP / Shutterstock
Recent U.S. trade policy has been more restrictive than at any time since the Great Depression. The Trump administration has applied new tariffs on billions of dollars of imports into the United States. (Ironically, the Reciprocal Tariff Act that Roosevelt signed gave the presidency the authority to do so.) But does this mean we are headed for the same fate as 90 years ago? What are the potential investment implications of higher U.S. tariffs?
First, a Primer
Tariffs are a tax on goods imported into a country and are typically charged as a percentage of the price that a buyer pays to the foreign seller. In the U.S., these taxes are collected by U.S. Customs and Border Protection and are contributed to the U.S. Treasury Department’s general fund. Historically, before there was a U.S. income tax, tariffs were heavily relied on to fund the U.S. government. Now, they are mostly used to try to protect U.S. industries from foreign competition. As of the end of the last fiscal year, the U.S. government collected approximately $35 billion in tariffs and import fees, which accounted for only about 1% of federal revenue. Last year, the volume-weighted average tariff on imports into the U.S. was 2.4% but the actual amount can vary greatly depending on the imported good. For example, despite the low overall average tariff, the current tariff on imported tobacco is 350%.2
As stated above, the primary goal of most tariffs in the modern era has been to protect domestic industries from foreign competition and to protect jobs in manufacturing. The two most recent cases that precede the Trump administration did not have stellar results. In 2009, the Obama administration applied tariffs of 25%–35% on tires imported from China. At first, the tariff appeared to be effective as U.S. imports of tires produced in China dropped in 2010. Unfortunately, imports of tires from South Korea, Thailand, and Indonesia more than made up the difference. U.S. production of tires increased after the tariffs were initiated, but many people believe the growth in production had more to do with an improving economy than the impact of the tariffs, which expired in 2012.
In 2002, the George W. Bush administration imposed tariffs on steel of up to 30% in order to protect the U.S. steel business. According to a report by the U.S. International Trade Commission, the tariffs led to supply difficulties, production delays, and higher prices passed on to consumers3 . Other countries filed grievances with the World Trade Organization and threatened new tariffs of their own. Under this pressure, the Bush administration elected to remove the tariffs just one year later in 2003.
That Was Then, This Is Now
The Trump administration’s tariffs have been quite a bit broader in scope than the last two examples. They started out relatively small, with tariffs applied on approximately $10 billion worth of imported solar panels and washing machines. Then, in March of this year, they announced tariffs on $48 billion worth of imported steel and aluminum (these tariffs were later modified down to about $18 billion). But by far, the largest tariffs have been imposed against imports from China. Tariffs on approximately $200 billion of Chinese imports into the U.S. were imposed in late September and the Trump administration is considering applying tariffs to all imports from China (approximately $460 billion in imports).
General economic theory contends that two things happen when one country applies tariffs to imports: reciprocity and higher prices for goods. Not surprisingly, all the recent tariffs were met with some kind of retaliation from the countries that were affected. For example, China applied a tariff to U.S. soybean exports and the eurozone added tariffs to U.S. exports of Harley-Davidson motorcycles, blue jeans, and bourbon. To date, the U.S. now has tariffs on 12% of its total imports, while the combined retaliation from trading partners covers 8% of U.S. exports4. These additional tariffs are basically a tax on international trade and therefore increase prices of the products affected.
Up until recently, the tariffs only had a marginal impact on stock and bond returns as the total value of tariffs was small relative to total output. That thinking has changed after the recent $200 billion escalation with China. During recent earnings announcements, some companies are beginning to report that they expect their input prices to rise going forward partially due to increased tariffs. Additionally, companies, including Walmart, Ford, and Macy’s, have said they may have to raise prices due to higher input costs. Although we are not there yet, the worst-case scenario would be a further escalating trade war between the U.S. and China that leads to higher-than-expected inflation. This situation would potentially damage the profitability of U.S. corporations while also leading to higher interest rates, neither of which are good for stocks and bonds.
But are there any possible benefits? The tariffs were enacted to accomplish two main goals. The first goal is to increase U.S. manufacturing output and therefore increase manufacturing jobs. The second goal is to negotiate better trade practices on intellectual property and technology, specifically in regard to China. Whether or not the first goal is met may take some time to determine. Tariff policy seems to be changing rapidly and it will take some time for businesses to decide whether to shift production to the U.S. from overseas. The goal of moderating China’s laws on intellectual property is a logical and practical pursuit and threats of higher tariffs may help facilitate those discussions.
It remains to be seen whether the Trump administration’s more aggressive trade policy will yield the desired results. As the experience of the 1930s demonstrated, tariffs initiated by one country can backfire, leaving all countries in worse shape. We’re hopeful that today’s world leaders will heed the lessons of history as they navigate the ongoing trade negotiations.
1. Bill Krist, “Did the Smoot-Hawley Tariff Cause the Great Depression,” Washington International Trade Association, June 16, 2014.
2. Paul Wiseman and Christopher Rugaber, “Trump’s tariffs: A closer look at what they are and how they will work,” USA Today, July 9, 2018.
3. Steel: Monitoring Developments In the Domestic Industry, USITC, September 2003, Publication No. 3632
4. Chad P. Bown and Melina Kolb, “Trump’s Trade War Timeline: An Up-To-Date Guide,” Peterson Institute for International Economics, September 24, 2018.